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however, more open on the export side than on the
import side – not unlike Japan and South Korea
some time ago. Clearly, the restrictions of foreign
competition on domestic markets (even by foreign
firms with production in China) are in conflict with
the government’s recently expressed ambitions to
pursue a more ambitious competition policy.
CHINA’S REFORMED ECONOMY
ASSAR LINDBECK*
I
t is easy to identify China’s main economic
achievements in connection with the country’s
transition to a new economic system: a GDP growth
rate perhaps as high as 9 to 10 percent per year since
around 1980; an eightfold increase in per capita
income; and a fall from 50 to 10 percent of the share
of the population living in “absolute poverty”. This
last category is then defined as individuals living on
less than one dollar a day. However, it is also important to be clear about the resource costs connected
with China’s rapid growth path as well as lingering,
and in some fields increasing, social problems.
Deficient factor markets
Factor markets have, however, not been reformed to
the same extent as product markets. This shows up in
labor markets, financial markets as well as the market for land. The labor market has a pronounced
insider-outsider character: employees in state firms
are privileged in terms of wages and, even more,
when it comes to various social benefits – a feature
which limits the flexibility of the labor market. The
insider-outsider character of the labor market in
urban areas is accentuated by the household registration system, the urban hukou, which requires a
permit for living in urban areas. While the implementation of the hukou system has recently been
softened, it continues to discriminate against
migrants who have actually settled down in urban
areas without permits. Indeed, the approximately
140 million individuals living in cities without permits today – the so-called “floating population” – are
the most pronounced “urban outsiders”. This is not
only reflected in their relatively low wages, but often
also in particularly unhealthy working conditions, as
well as in their limited access to affordable human
services such as health care and education.
Nature of the economic reforms
Since the late 1970s, when the economic reforms
started, the sequential privatization of collective
agriculture farms, Town and Village Enterprises
(TVEs) and a large number of state firms has drastically changed the ownership structure in the country
– a development accentuated by the entry of new
private firms, domestic as well as foreign. As a result
of these developments, about 60 percent of the
aggregate production in China today seems to take
place in privately controlled firms. China’s economic
system has, however, changed dramatically also in
other dimensions than the ownership structure.
Economic decision-making has been decentralized
from government authorities to households (in the
case of consumption) and to firms (in the case of
production and investment); command has, to a considerable extent, been replaced by economic incentives; administrative processes by markets; monopoly by competition; and autarky by internationalization, codified in China’s entry into WTO in year
2001. Broadly speaking, the Chinese economy is,
Financial markets are even less reformed, and less
developed, than labor markets. Indeed, the poor
functioning of financial markets is a basic weakness
of the economic system in China. For instance, state
banks still dominate the market for loans and, during
the last decades, they have allocated about two thirds
of their lending to public-sector firms, mainly SOEs.
Since the loans have often been quite “soft”, they
have in many cases turned out to be non-performing
(neither being amortized nor paying interest).
Although the emergence of informal credit and cap-
* Institute for International Economic Studies, Stockholm University and IFN Stockholm. The paper largely builds on Lindbeck
(2006) and (2008, forthcoming). The former study, in particular, also
contains relevant references. I am grateful for useful comments on
a draft of this paper from Nannan Lundin and Fredrik Sjöholm.
CESifo Forum 1/2007
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capital”. Clearly, these networks facilitate economic transactions (partly through reduced transaction
costs) among network members, which often
include not only businessmen but also local politicians and public-sector administrators. The network
system means, however, that China is an insideroutsider society also in the business sector; individuals outside the networks are disfavored. The clientele-like relations between representatives of the
public sector and individual businessmen also open
the gates for corruption, since some of the representatives are in charge of regulations and permits
of various types.
ital markets has mitigated the discrimination of private firms, the dual nature of financial markets in
itself is a distortion. New capital injections to state
banks by the government, and a shift of non-performing loans to special asset management institutions have, at least temporarily, “cleaned” the balance sheets of state banks. The non-performing bank
loans seem to have been reduced from about 30 percent to about 10 percent of the stock of bank lending. But a permanent removal of major risks of
financial instability naturally requires that state
banks discontinue their habit of providing soft loans
to state firms. Equally important: a higher quality of
bank lending is necessary for improving the allocative efficiency of investment and production, which
has for a long time also been harmed by the dominance of the government sector in the very thin markets for shares and bonds.
“Asset stripping” in connection with the privatization of firms is another example of corruption in
China – often favoring either the management of the
firms or public-sector administrators, or both.
During the transition period, such asset stripping,
like some other types of kick-backs, has probably
speeded up the creation of a class of private capitalists, which is likely to have been conducive to entrepreneurship. However, if corruption becomes a permanent part of the Chinese economy, it is likely to
have negative consequences for the allocative efficiency of the economy in the long run; at least, this is
a general experience in many other countries. Moreover, it is difficult to get rid of corruption as long as
politicians and public-sector administrators have
something to sell – like permits of various types. This
is an additional argument for further deregulation of
the Chinese economy, in particular by reducing the
requirement of discretionary permits of various
types.
The market for land is even more dominated by the
public sector, simply because all land is owned by
the public sector and leased to private agents.
Naturally, this feature of the economic system has
particularly important consequences in agriculture,
although the present arrangements are vastly more
efficient than the old system with collective agriculture communes. Since land-lease contracts are less
“complete” than ownership contracts, the ownership structure for land is bound to hamper both
investment decisions in existing farms and the consolidation of land holdings, and hence also the possibilities of exploiting potential returns to scale in
agriculture. Land-lease contrasts are also less useful
as collateral for borrowing than ownership contracts. All this means that China pays a heavy price
for its lingering socialist ideology when it comes to
the ownership of agricultural land. While Deng
Xiaoping is famous for his metaphor that “the color
of the cat does not matter as long as it catches
mice”, the color of land contracts in agriculture
does seem to matter.
How, then, should we characterize China’s economic system today? Some observers use the term
“state capitalism”. This is, however, a rather misleading term since more than half of the aggregate
production is performed by private firms.
Moreover, high household savings (20 to 25 percent
of the disposable income) and large plowed-back
profits in private firms are likely to gradually
increase the private share of the ownership of firms
and assets. The term “market socialism”, launched
by Oskar Lange and Abba Lerner in the 1930s, is
misleading for the same reasons. I would simply
characterize the system as a “mixed economy”,
although with some specific characteristics such as
(1) a relatively high openness to the outside world
(as compared to other large countries), (2) more
private ownership of firms than of assets (in particular land and financial assets); (3) considerable
A network economy
Deficiencies in the implementation of the “rule of
law” are another major weakness of the economic
system in China, although the legal system in the
economic field has gradually improved during the
last two decades. To some extent, the remaining
deficiencies are compensated for by informal networks based on personal relations, guanxi, which
may be regarded as a Chinese version of “social
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political and bureaucratic interventions in state
enterprises; (4) poorly developed factor markets, in
particular the financial markets; (5) tight networks
among business men partly replacing the ”rule of
law”; and (6) a pronounced insider-outsider division in society at large – in labor and capital markets, in the business community as well as in the
case of social arrangements.
My tentative conclusion is that China has a great
deal to gain from moving to a more intensive growth
strategy by shifting resources from investment in
real capital assets to human capital; increasing the
flexibility in factor markets; raising the relative
prices of energy and raw material (for final users);
and limiting the enormous tear on environmental
resources, in particular land, air and water. Less realcapital intensive production would also boost
employment.
Inefficiencies of the growth strategy
In spite of China’s extraordinary success in terms
of GDP growth, there are strong indicators of serious limitations in the efficiency of the growth
path: the resource costs have been relatively high.
One indication is the high aggregate investment
ratio, today about 43 percent of GDP, which has
resulted in a very high marginal capital-output
ratio of 4 to 4.5, indicating rather low capital productivity. The marginal capital-output ratio has
also gradually been rising over the last two
decades, which may indicate falling capital productivity. As compared to the huge investment in
real capital assets, the investment in human capital looks relatively modest around 4.5 percent of
GDP, of which less than 3 percentage points are
financed via government budgets. Although a high
rate of capital accumulation is natural for a country that gives high priority to economic growth,
the division between real capital assets and human
capital looks quite lopsided, the proportions being
ten-to-one.
Large income gaps
Uneven regional economic development is another important aspect of the Chinese growth path.
While the GDP growth rate in some provinces has
been more than 12 percent per year since around
1980, it has been only half as high in others. As a
result, per capita income in the most developed
provinces (and large cities) is about seven times as
high as in the least developed ones. Indeed, the
geographical differences are so large that China
resembles a continent, consisting of both semiindustrial countries and some of the poorest countries in the world, rather than an ordinary nation
state. Another aspect of the geographical income
divide is that per capita income is about three
times as high in cities as in the countryside. These
geographical divides are largely the result of the
specific economic policy strategy followed by the
government. One example is the selective opening
of the Chinese economy for foreign direct investment through the Special Economic Zones in
some costal provinces in the 1980s. Other examples are the concentration of infrastructure investment to these provinces and, until recently, the
unfavorable price and tax system for farmers
(except during the early reform years in the early
1980s).
The huge consumption of energy, raw materials
and environmental values is another indication
that the growth path is highly extensive (resourceusing), largely a result of distorted prices on such
products. Although China has gradually become a
more efficient user of energy, the country seems to
use twice as much energy per unit of output as
other countries (Bergsten 2006, 34). The extensive
growth path in China is also reflected in the rather
moderate rate of “multi-factor productivity
growth”,1 which seems to have been about 1.5 to
2.5 percent per year during the transition period –
a measure of technological and organizational
improvements.
The income gaps in the country have, however,
widened also within narrowly defined geographical
areas, such as within municipalities, largely in connection with the increased return on human capital. This is to a considerable extent a side effect of
the shift to an economic system based on economic incentives rather than command – without deliberate policy actions to mitigate the distributional
consequences. For instance, the Gini coefficient for
the overall distribution of household income seems
to have increased from 0.28 in 1980 to 0.40 to 0.45
today.
1
The total factor productivity growth excluding investment in
human capital and reallocation gains in connection with the shrinking agricultural share of the economy (see Lindbeck 2006, 32–33).
Total factor productivity (TFP) growth seems to have been 1.0 to
1.5 percentage points higher than multifactor productivity growth,
as a result mainly of the huge reallocation gains.
CESifo Forum 1/2007
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What explains China’s economic success?
trade because of the huge difference in factor proportions between China and developed countries.
After all, the gains from trade tend to be larger, the
more the factor proportions differ among trading
partners. The situation is more problematic for a
number of developing countries with similar factor
proportions as China, and probably also for some
transition economies in Eastern Europe and former
Soviet Republics. For all these countries, China is
likely to become a serious competitor, in particular
in the field of labor-intensive products.
It is not easy to say which specific features of
China’s new economic system that have been most
conducive to the country’s impressive growth performance from the late 1970s. A trivial, but possibly
correct, answer is that the success depends on the
combination of reforms in all the earlier mentioned
dimensions of the economic system, since this combination seems to have released earlier repressed
individual initiatives. When it comes to GDP
growth, the release of individual incentives has obviously dominated over the brakes on the economic
efficiency of the remaining weaknesses of the economic system. It is, however, also tempting to
hypothesize that the gradualism and the experimental nature of the reforms have been conducive to the
economic success. In particular, gradualism (including the slow reduction of the overstaffing of SOEs)
seems to have helped China balance job creation
and job destruction much better than in transition
countries pursuing a Big Bang strategy. This may
very well be a main explanation as to why China, in
contrast to many other transition economies, avoided negative consequences for GDP growth during
the early period of transition, and a related explosion of unemployment.
However, some observers argue that China today is
also a large producer of human-capital intensive and
high-tech products and that developed countries are
therefore threatened by stiff competition from
China also for such products. This view is based on a
misinterpretation of official trade statistics, however. It is true that China exports large volumes of
products with considerable high-tech content, such
as video recorders, television sets and mobile
phones. But the high-tech content of these products
consists of intermediary products imported from
other countries. The domestic value added in China
of these exported products is, in fact, based on lowskilled labor and low-tech production methods.
Indeed, the domestic value added of the export of
electronic and information technology products
seems to be no more than about 15 percent of the
export value of these products (Branstetter and
Lardy 2006). Moreover, in 2003, the domestic production of semiconductors is reported to have been
less than a tenth of the value of the imports of such
products (Baijia 2004).
As emphasized by Presad and Rajan (2006), for
instance, the gradualist strategy could run into problems in the future. Major coordinated reforms may
be crucial for further economic progress in some
cases, for instance in order to build up market supporting institutions, improve the functioning of factor markets, reduce discretionary government interventions in state enterprises and mitigate corruption.
There is also the risk that a prolonged, gradualist
reform process finally comes to a halt as a result of
the build-up of strong interest groups and the emergence of related “veto points”.
Consequences for the outside world
Today, China is thus most appropriately regarded
as a major assembly platform for imported hightech components – indeed, the major platform of
this kind in the world. As long as China buys most
of its high-tech intermediary inputs from developed and semi-developed countries, it is not likely
to be a large scale threat to high-tech firms in other
countries.
In the future, China’s emergence as an important
actor on international markets may very well be
regarded as a major event in modern economic history – possibly comparable to the entry of the
United States into the world markes in the late 19th
and early 20th century. In several respects, this is
likely to be economically favorable for developed
countries. In particular, new opportunities are
opened for these countries through the gains from
Naturally, in a long-term perspective, China will
probably considerably expand the production of
high-tech products and, in this connection, gradually upgrade its position in the international hierarchy of production tasks. Indeed, the Chinese
authorities have expressed a concern of just being
an assembly platform for foreign firms, rather than
having a vital indigenous technological development. If China succeeds in upgrading its production
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in domestic firms, both the traditional product cycle
and the international “task cycle” (i.e. shifts in the
international location of production tasks within
vertically integrated production processes) is likely
to be speeded up. Developed countries that are able
to continue shifting to new and more sophisticated
products and production tasks do not have much to
fear from this development, although certain
groups of individuals in these countries are bound
to lose, possibly not only in relative but in some
cases also in absolute terms. Countries that are not
flexible enough are likely to run into serious problems – with a likely boost of protectionist pressure
from groups in such countries that find themselves
threatened.
New social arrangements?
Although the new social ambitions so far have been
more pronounced in the rhetoric than in actually
pursued policies, China has clearly entered the
route towards new social arrangements, indeed
towards modest welfare-state institutions.
However, a basic weakness of today’s social
arrangements is the one-sided emphasis on the
interest of urban insiders at the expense of broader
population groups, in particular individuals with
low-income and the rural population in general.
However, when dealing with this issue, it is important to remember that the potentially appropriate
arrangements in the social field differ considerably
between urban and rural areas. In the cities, the
authorities could provide better income security
“simply” by widening the group of citizens covered
by social insurance, such as unemployment insurance, health-care insurance and retirement pensions – although this may require less generosity
towards the most privileged groups today. Social
insurance of this type is less operational in rural
areas. Indeed, unemployment and retirement (and
often also income) of individual households in agriculture are often even difficult to define and document. For the agriculture population, it may, therefore, be easier to rely on crop-failure insurance and
lump-sum transfers rather than ordinary (general)
income insurance. As a comparison, it was rather
late in their development process that today’s
developed countries extended income insurance to
the agriculture population.
Social challenges
The huge increase in per capita income for a billion
of the poorest people in the world, and the drastic
reduction in the number of individuals in China living in “absolute poverty”, do not only constitute an
important economic achievement. These developments also imply important social progress. However, the social development in China has been disappointing during the reform period in several
other respects. One important reason is that the
previous social arrangements, tied to work places
(danwei), broke down at the same time as citizens
became more exposed to market risks. Moreover,
social benefits tied to the individual’s work place
do not sit well in a market economy, where it is
important that social benefits are portable across
workplaces.
The provision of human services suffers from the
same types of problems as the arrangements for
income protection. Once more, the urban insiders
are favored as compared to the rest of the population. Indeed, the distribution of education and
health care seems to be at least as uneven as the distribution of household income. The basic problem is
the way in which such services are financed. For
instance, the government budget today finances
only 63 percent of total spending on education in
the country. The rest is mainly financed by various
organizations, including firms and organizations
connected with firms, but also by out-of-pocket
money from households (in particular in the case of
higher education). Even more striking, in the case of
health care, public budget financing only accounts
for about 40 percent of total spending, and the
remaining part is mainly financed by out-of-pocket
money from households.
Clearly, the political authorities in China are fully
aware both of the serious social problems in the
country and the defects of exiting social arrangements: the huge income gaps across geographical
areas and among individuals, the lack of income
security for the majority of the population and the
uneven distribution of the provision of human
services such as education and health care.
Indeed, at the 11th Congress of the Communist
Party in early 2006, the leadership announced a
shift from the one-sided emphasis on GDP growth
to the new ambition to create a “harmonious”
society with greater concern for regional and
social balance, and hence for future social stability. It remains to be seen to what extent, and how
fast, this announcement will be reflected in actual
policies.
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China, while university education is rapidly expanding. It would seem that China is approaching a pronounced duality (polarization) in terms of schooling, with a rapidly expanding group of individuals
with a high academic education combined with a
large group of individuals with both little theoretical
and vocational training.
It is easy to understand that low-income groups have
serious difficulties in getting adequate schooling and
medical care with these financial arrangements.
Moreover, since local rather than national authorities are responsible for public-sector financing of
education and health care, the huge variations in tax
revenues across local authorities make the provision
of such services highly uneven across geographical
areas. It is difficult to see how these problems could
be effectively dealt with without a shift of a large
part of the financing of education and health care
from private individuals to the public sector
(through taxes or a mandatory insurance premium),
combined with a huge expansion of central government transfers to poor local governments.
Developed countries today also experience serious
efficiency problems in the field of health services
– in some countries largely in the connection with
rationing and queues, in other countries in the
form of cost explosions, partly as a result of ex post
moral hazard (such as unnecessary expensive medical examination and excessive medication and
surgery). China has already encountered similar
efficiency problem – in addition to the poor access
of health services for low-income groups. The efficiency problems are reflected, for instance, in
extremely high prescriptions of drugs and the
application of sophisticated and often hardly necessary surgery for a small fraction of the population (Eggleston et al. 2006).
Social lessons from developed countries
When launching more ambitious social policies,
China could learn a great deal from the experiences
in developed countries. On the “positive” side, the
main lesson might be that it is possible to provide
quite ambitious social arrangements without endangering a continuation of per capita economic
growth. There are, however, important reservations
to this observation. If the generosity of income
insurance exceeds certain limits (which are difficult
to empirically determine in advance), the systems
may not be financially viable in a long-term perspective. One reason is that serious problems of
moral hazard may emerge – an aspect that politicians in developed countries have usually underestimated, or even entirely neglected. In Europe, this is,
for instance, reflected in long spells of unemployment, high sickness absence and a large number of
individuals living on highly subsidized early retirement. Such moral hazard problems may be particularly severe, if social norms against exploiting various benefit systems weaken over time when more
individuals choose to live on such benefits
(Lindbeck 1995). China is well advised to be aware
of such problems when new social arrangements are
considered today.
The complications concerning financing, incentives
(including moral hazard) and efficiency of social
arrangements hardly constitute a basis for delaying
radical reforms in these fields in China – either for
income protection or the provision of human services. However, the complications call for caution to
avoid future “overshooting” of the generosity of the
benefit levels – and related risks of conflicts between
social and economic ambitions. My interpretation of
the international experiences in this field is, however, that the risk for serious conflicts between social
ambitions and concern for efficiency/growth does
not only depend on the level of social spending, but
largely also on the method through which social policies are pursued.
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